Monday November 19, 2018

Case of the Week

LoBank Directors Vote to Sell

Case:

Barbara Banker started with nothing. Barbara lived in a midsized town and worked in the local hardware store. The store owner noticed her industrious efforts and strong work ethic. When he decided to retire, he suggested that Barbara could take over the hardware store and pay him over a term of 10 years from store profits. Barbara did exactly that. In fact, when the town drugstore owner wanted to retire, Barbara bought the store under a similar plan. Later, Barbara started buying apartment buildings in town. Since she needed financing for these purchases, Barbara became good friends with the town bankers.

Two bankers eventually approached Barbara about starting a new local bank. She agreed to be one of the initial directors and they all invested in the local bank, which they named LoBank. Over the years, the bank's services and value greatly increased. Barbara is a respected businesswoman and she now owns a large, valuable block of LoBank stock.

As a strong supporter of her local community, Barbara gives regularly to her favorite local charity. She would like to make a large gift of bank stock to the local charity to be used to build a new youth center. But as a director she knows that LoBank's directors have approved signing a letter of agreement for the sale of all stock to MegaBank, a bank located in a nearby large city. Barbara decides to meet with her CPA to discuss the gift.

Question:

Barbara explained, "My favorite charity would like to name the new youth center after me. I am interested in supporting youth, and this center would be a fine addition for our town. The LoBank stock has gone way up in value, but I have heard that there may be problems with this gift now that the board voted to accept the offer from Megabank. Can I still make this gift? Are there any problems?"

Solution:

Barbara's CPA explained that it probably will not be possible to make a gift of LoBank stock at this time and still bypass the capital gain. Typically, the third step in the bank sale process is a vote by the board of directors to accept the buyer's offer and submit the proposed sale to the shareholders. Normally, the vote by the board of directors does not create a binding obligation for sale.

Under applicable state law, the sale of a corporation normally will not be completed without a vote by more than 50% of the shareholders. However, if the directors own more than 50% of the shares, the IRS may take the position that the vote by the board of directors is equivalent to a vote by more than 50% of the shareholders and that there is a binding agreement.

Because the directors of LoBank collectively own 55% of the total shares and voted for the sale, the probability that the sale will not go through is "remote and hypothetical and therefore irrelevant." Therefore, the vote by the shareholders is a mere formality. It is probable that the IRS and the Tax Court would conclude that the obligation is now effectively binding and that the sale is subject to the binding agreement standard of Rev. Rul. 78-197.